"Let's say that two gay men, of unknown health status, want to have informed, consensual, unprotected sex. Should the law prohibit this? I believe the answer is no. Furthermore it is not just a matter of enforcement difficulty, it is a question of autonomy. If you don't think so, modify the example so that two heterosexual people want to have consensual but unprotected sex. And so on.

The unprotected sex is riskier and less prudent than borrowing money at an annualized rate of two hundred percent. Why prohibit one and not the other? Many of the borrowers are being fooled, but others have legitimate reasons to seek the money, such as wanting to buy a birthday present for a visit to one's child, living with a separated spouse."

By the way, this also relates to healthcare reform and moral hazard in a significant way, just as overeating and not exercising matter.

I hear a lot of people talk about how "dumb" it is that America will spend a trillion dollars a year on terror-prevention but won't spend the same amount on healthcare, when the number of victims of terror over the last 10 years is one to two orders of magnitude smaller.

For this particular argument, I'm going to set aside the actual terror-prevention we got, and the actual healthcare reform we got, and look at these more generally. There are many arguments stating that our anti-terror actions have made us more vulnerable to terror in the last decade; I'm not enough of a foreign policy expert to assess those claims either way. For our purposes, let us assume that terror-intervention actually reduces terrorism by some amount. Similarly, I have argued a number of times that the healthcare reform that passed will kill more people than it saves by restricting healthcare technological innovation, significantly slowing the economy and reducing future stability domestically and abroad; for the purposes of this argument, I will assume instead that a better healthcare bill had passed and it really did insure everyone, cut down on the 'pre-existing' and dropped coverage debacles, and save a lot more people without these negative effects (anyone interested my general vision of what this bill would have to look like is welcome to click on the "favorite links" section to the right).

Let's also ignore the fact that a) good healthcare and good anti-terror are not mutually exclusive if designed to be fiscally appropriate and b) cost-benefit on a lives basis is certainly not the only way to think about these things. The argument treats them as alternative uses of the same cash, and uses a cost-benefit on a lives basis, so that is the argument I will assess.

There are two major, major fundamental problems with the line of thinking that universal healthcare is automatically a better investment for the country than anti-terror spending because of expected lives lost to lack of insurance vs terror. Firstly, the assumption ignores tail risk, and secondly, the assumption ignores correlational stability.

The tail risk issue has an important analog - securities investing. One of the hallmarks of bad investing is that it weights returns heavily, routine risks somewhat, but significantly underweights tail risks. When you buy a company, you often think of how much you can earn first, what the probability is that you'll lose money due to routine competition second, and you probably don't think of megaproblems (An Enron-style scandal, an earthquake under their only factory, massive counterparty default). However, it is the megaproblems that define the competitive landscape in the long term. As a potential example, Citigroup may have had all sorts of competitive advantages over Wells Fargo in the years leading up to 2008 in terms of profitability, growth, etc, but Wells is the stronger company by far for the long run because Wells was better situated for disaster.

Similarly, terror spending is not about "routine" terror. If terror attacks were only about the lives lost (more about this in a second), then the occasional death of dozens, hundreds or even thousands of people would in fact be less than the thousands or tens of thousands of people who die annually from lack of health insurance (best number we have is about 20,000 a year, I think, though this number is disputed).

Terror outcomes have a distribution, and the tail of that distribution can stretch a long, long way. A successful EMP attack would require only one nuke, exploded high in the atmosphere, and could potentially disable the entire country's electronics. We're talking 100 million deaths. If that has a 1% chance of happening in the next 20 years, that's still an annualized 50,000 people in expected value. A biological attack could do something similar - perhaps that's another 50,000 people. And onwards it goes into other types of attacks. Casualty counts are hard to estimate, probabilities even more so, but if you're looking at an expected value, looking at the last 10 (or even 200) years for casualty counts does not adequately capture the tail risk of a first-in-history-but-still-possible type event. That expected value far exceeds the casualty count of healthcare. Perhaps there's an argument for spending on cutting tail risk instead of cutting overall terror risk, but that's not the argument opponents are making.

The second issue is less intuitive, but it has to do with correlational stability. Every death is certainly a tragedy, but clusters of deaths, for a society, are far more difficult to deal with. If an additional 1 person in every town or borough in America (25,375 total) passed away tomorrow, it would be really, really sad, but those towns would survive. If 25,375 people from one town passed away tomorrow, it would kill the town. If somebody thinking of moving to that town, or starting a business in that town, or selling their wares in that town, had to worry consistently about large scale numbers of deaths in that town happening at random, their own risk minimization would result in the town itself becoming highly unstable and a terrible place to live as everybody refuses to build out infrastructure for fear of it being rendered useless in a flash... even before any actual deaths happened. So while "routine" terror attacks may kill far fewer people than lack of healthcare, the effects of a lack of healthcare are roughly randomly distributed throughout the population, whereas terror attacks have the prospect of striking anywhere, and wherever they strike will have a large number of people disabled and infrastructure taken out. Terror is thus far more destabilizing than lack of healthcare and may kill more people in the long run by making people unwilling to invest in infrastructure that would save lives in the future.

I don't wish to be callous in a cost-benefit analysis; every death is a tragedy. But to respond to a cost-benefit argument on its own terms requires a cost-benefit argument, and if the spending is exclusive, the cost-benefit argument is not as completely in favor of healthcare as its supporters think. In real life, there's a balance to be struck (they're not mutually exclusive initiatives, as long as spending on other issues can be reduced), but I'd like to hear more talk of tail risk and correlational stability, and less talk of absolute historical numbers and present conditions when people talk of the war on terror - it'd force us to focus better on the issues that really matter to the US anyway.

Friday, July 23, 2010

The handling of the Euro-crisis has been much, much worse than Bernanke and Geithner's handling of the initial US collapse. Despite the Fed's recent bizarre unwillingness to engage in further monetary stimulus, Bernanke and Geithner handled bank stress testing about as well as could be expected. They could have been stricter, certainly, but they did at least evaluate a number of different downside scenarios, even if they avoided catastrophe scenarios.

However, the Euro treatment of its crisis has been bizarre. First came Trichet's plea yesterday for the rest of the world to engage in austerity. While much of Europe requires austerity right now because they're having legitimate debt crises, Trichet should be begging the rest of the world to spend as much as possible because it would stimulate European exports and help them out of the crisis. The only plausible reason to beg for that is so that they can politically help Europe feel like it's suffering along with everyone else in order to avoid public criticism (or emigration). While I understand the political sensitivity of his situation, shooting your own foot off because it's easier for Europeans to pretend that the rest of the world was as fiscally irresponsible as they were is a stupid argument.

Today came the bank stress tests, which sadly, don't seem to be worth the paper they're written on.

A couple weeks ago, it came out that stress tests were examining banks under the assumption that Greek debt would pay 83% of notional principal and Spanish debt would pay 97%. These are laughable assumptions, given that Greek and Spanish debt are trading WELL below those levels, and even if you think the market is unduly pessimistic, they still should have tested based on market assumptions.

Then the results come out today and they ignore the possibility of any sovereign defaults and they ignore the results of a dissolution of the Euro, because European authorities (at least publicly) feel they need to dismiss these concerns as impossible. The only stresses applied were defaults on privately issued assets.

While it's useful to have detail on the Greek, Spanish, Portuguese, etc. sovereign debt holdings on banks, the stress tests did not apply anything remotely approaching the most stressful set of likely conditions, which is what you'd want to see a stress test do.

7 of 91 banks STILL failed. Should we be looking at ALL European banks as compromised, given the likelihood of a sovereign default somewhere, and the very real possibility of Euro dissolution? More pertinently, wasn't the point of the stress tests to get investors to stop freaking out about the possibility that all European banks are compromised? If a stress test is designed so that it inspires no confidence in banks that passed, but scares the shit out of us when banks fail and actually affects our perception of passing banks because of failure rates despite lax assumptions, doesn't that make the stress tests useless?

The US had no banks fail, or come close to failing, much stricter stress tests, despite similarities in the level of government recapitalizations/bailouts (and in many cases, less recapitalization and bailout). Say what you like about irresponsible mortgage lenders (hi Countrywide!) and poor credit structuring by banks, but in terms of capital regulations and bank leverage, US banks performed much better in the boom years than European ones despite allegedly being way more irresponsible than their more-regulated European brethren. This should be something to think about for the "more regulation" crowd.

Thursday, July 22, 2010

Does this concern anyone else? I mean, I understand that journalists are people and they have agendas, but this sort of coordinated planning of reporting to favor certain candidates smacks of near-corruption.

Wednesday, July 21, 2010

Maywood, CA actually laid off ALL of its city employees and outsourced EVERYTHING - police, crossing guards, firefighters, all of it. Some of it they just pay other towns to do it for them, and others they hired private companies. Supposedly, it's working wonderfully.

While on the one hand this is bizarre, on the other hand, it's actually kind of heartening. Instead of being stuck with crappy bureaucracies, if another town or a private company is able to offer the same level of police coverage for less, or better coverage, then the town can switch. In effect, they're making use of competition to improve city services beyond what they were capable of doing internally. It's brilliant, and I wish more towns would look at the model.

I didn't realize that the mess of a financial reform bill just passed still contained the provision that the credit ratings agencies can be held legally liable for their ratings. This is ridiculous, because nobody can predict with 100% accuracy and forcing people to just makes them unwilling to make predictions, and whatever you feel about the quality of ratings predictions, they do provide useful information to back up their ratings (as an analog, I may not agree with a research analyst's buy recommendation for a stock, but I'm usually interested in why THEY think it's a buy).

Agencies refusing to rate loans (or, to a lesser extent, refusing to accurately rate a loan by not giving any good ratings for fear of liability) means that it's harder to sell those loans. If the issuer needs to keep them because they can't sell them, that increases risk for the issuer. They need to raise interest rates to compensate for that additional risk. In other words, it raises the cost of capital substantially at a time when we really want to stimulate consumption by lowering interest rates and reducing the cost of capital. I noticed Mankiw picked up on this as well - it's brutally anti-stimulatory at a time when we're desperately looking for cost-effective stimulus.

More and more pieces of the financial reform bill look like they may stall a recovery. They cripple banks' earnings potential for a while, and they will almost certainly result in less lending. They will also almost certainly result in bigger bank fees, which presumably will shrink deposit bases and thus lending as more people either stash cash under the mattress or turn to other methods of saving or investing. Hopefully, de-banking people would result in more spending, but de-banking has the ability to stimulate a lot of illegal activity (theft, as well as the immediate temptations of drugs and prostitution - the third world suffers from this de-banking problem significantly) and result in more disparate and worse socioeconomic outcomes for low-income people.

In short, Congress really does seem unable to think about second-order consequences. Something to ponder for the "more government intervention" crowd.

The number of job openings is actually reasonably robust right now, but the labor market isn't clearing.

A number of reasons that have been presented:

1) Extended unemployment benefits mean that people are overly selective about what jobs they take.

2) A sectoral shift in US production, where construction workers aren't trained enough to be nurses, for example

3) Businesses used the recession to upgrade critical systems to cut costs, but these critical systems are largely more sophisticated than older ones and thus require more educated people to operate. The bulk of the unemployed are less educated, and thus aren't a fit for the positions.

4) People are underwater in their mortgages, or defaulted on their mortgages, and thus aren't able to move to another place for a new job. Thus, people are limited in the jobs they could take (another reason to LET THE HOUSING MARKET CLEAR).

5) Openings are for prospective future demand, not current demand, and current demand is low enough that employers can afford to wait and be choosy.

Another I thought of is that

6) Companies are posting for jobs they laid off so they have the ability to rehire quickly, but they don't intend filling the jobs anytime soon, or perhaps are waiting to see if they want to even bother rehiring in the US.

It's almost certainly a combination of all of them, but it is something to keep an eye on.

Bryan Caplan's article was very interesting. He looks at a strict libertarianism (as opposed to the marginal libertarianism I usually advocate for), so the pieces I excerpt below are the pieces I see as the non-obvious things (unlike things like "the government still has a role to play in the economy in the face of monopoly, externalities, etc", which I see as obvious)

Incrementalism:

"I think we should cautiously modify existing laws instead of abolishing them willy-nilly."

Immigration:

"A few liberals - and many libertarians - literally advocate open borders. I recognize that immigration is the greatest foreign aid program in human history, and I sympathize with the plight of would-be immigrants in the Third World. Most immigrants - legal or not - are nice people. But open borders is crazy. It seriously risks killing the goose that lays the golden eggs. I'm very open to more cost-effective and humane ways to deal with the negative effects of immigration. But as long as immigrants are eligible for government benefits, hurt low-skilled native workers, and vote, the only people we should readily admit are the highly-educated and clear-cut humanitarian cases. "

Foreign Policy:

"[L]et me turn to foreign policy. Here again, liberals engage in much wishful thinking, and libertarians compound their errors. Modern warfare is terrible. Most of the people the United States kills in places like Iraq and Afghanistan are innocents. If there were some way to spare them and successfully fight our mortal enemies at the same time, I'd strongly advocate it. Unfortunately, there doesn't seem to be any way to do so. Muslim terrorists really do want to wipe us off the face of the earth, and they're happy to use fellow Muslims as human shields to do it.

I know, they "only" murdered 3000 people on 9/11, but the distribution of terror has a long right [tail]. Slightly better planning by the terrorists could have multiplied the deaths by a factor of 10. The next big attack could easily be bigger by a factor of 100. And if you think Americans "overreacted" the first time, wait and see what they'll support the next time around. Liberals and libertarians who impede decisive action now are probably paving the way for worse things to come"

I thought I got a lot of flak from my Republican friends about my opinion that Bush was incompetent. (I also got some flak from my Democrat friends about my opinion that Bush was well-intentioned.)

However, even a lot of Republicans would agree once I had set out my opinions about Bush - There's a difference between idea and execution, and you don't have to oppose the idea of going to war in Afghanistan or Iraq in order to oppose his particular mismanagement of that war. Some would agree, some wouldn't, but they'd listen.

The level of vitriol I get for my opinions about Obama, however, is on another level of magnitude. The mainstream media reports a great deal on fringe Republicans who believe anything bad said about any Republican is an excoriable heresy, but certainly personally, where I know a lot more fringe Democrats than fringe Republicans, I know a lot more Democrats who are unable to hear anything contrary to Progressive ideology and respond to it reasonably.

Setting aside the psychology of group creation and unreasonable in-group vs out-group response, however, an outline of the exact reasons for my opinions on Obama starts to tell a story that looks a lot like the Bush story, with the economy as the backdrop instead of war - maybe he means well, but the economy cares about Progressive economic ideals about as much as the climate cares about Conservative energy ideals, and in dealing with the actual economy, he is stunningly, historically incompetent.

I will deal with the twelve steps that have concerned me most (hence "the dirty dozen") step by step, with sources listed as necessary in each step.

1) Healthcare reform.

The US seems to have divided itself into two camps: the pre-2010 system supporters and government healthcare supporters (including Obamacare). This dichotomy has never made any sense to me, because as with a war in Afghanistan and Iraq, there's a difference between concept and execution when it comes to universal healthcare - you can oppose Obamacare and still support universal healthcare. Healthcare is also not a unitary good - you don't "have healthcare" or "not have healthcare", you have different levels of healthcare, which makes defining "universal healthcare" more difficult than it appears. The only way healthcare is unitary is if everybody needs to have exactly equal healthcare access, but this is suboptimal - if I have 1000 dollars and you have 100 dollars, it doesn't help you if I burn 900 dollars to make us equal. The goal should have been "give everybody a baseline level of healthcare, and subject to that constraint, minimize the difference between desired level of healthcare and actually given level of healthcare". This doesn't lend itself to a centralized system. What should have been fortunate is that there are plenty of ways to provide a baseline level of healthcare to everyone and kill pre-existing conditions, and not all of them require a centralized bureaucracy.

Still, with Democrats in power, we got a centralized system anyway (RIP Wyden-Bennett), which I've written about at length (footnotes 1.1, 1.2 and 1.3 are the highest-level looks at the healthcare system).

Nobody seriously thinks that healthcare reform is going to reduce healthcare spending - every structural piece, every known economic theory and the experiences of Massachusetts healthcare (and Florida hurricane insurance, as well) indicates that healthcare costs will accelerate, and the government will consolidate more insured onto their books at great expense. The CBO came out and admitted this two weeks after the bill passed - they acknowledged that it almost certainly increases the deficit and definitely doesn't bend the cost curve.

Employers thus face a triple whammy: 1) prospective significant healthcare cost increases per employee, 2) prospective significant tax increases to offset the increased deficit, and 3) the uncertainty of another healthcare bill in the next 10 years to try and fix the problems this bill was supposed to fix, which puts them in limbo. What's the logical response? Hire less employees (shifting from labor to more tax-advantaged depreciable capital when possible), and tax shelter as much of your operations as you can by shifting as much investment as possible from the US to abroad. This harms employment, this harms spending, and leads to cash pileup on balance sheets. Anyone noticed any of these things recently?

This one's insidious because most people don't understand what they're looking at, at all. The bill is not outright destructive the way healthcare was, but it does increase overall uncertainty (what's the next big unpredictable reform the Obama administration is going to come up with?), and more to the point, it is completely useless. The financial reform bill doesn't address a single thing that could cause this crisis or any other. It's an excuse to shepherd consumer protection laws through (most of which aren't terrible, theyr'e just orthogonal to serious reform, though there's a case for the idea that the interchange fee regulation is bad - see footnote 2.1 ) and to bash banks with buzzwords like "swaps" and "derivatives".

This bill does not address moral hazard at ALL (you don't wanna deal with moral hazard when its time to pay out, you wanna deal with it before the bad behavior can be undertaken - as in, now). The bill also seems to follow the logically incomprehensible dictum that (i'm paraphrasing one of the NY Times columnists here) "the establishment never caught this crisis, so let's make it more powerful and rely on it EVEN MORE next time." You see no market-distributed risk assessments (contingent convertible debt for banks, for example), you see no specific new incentives for banks to self-regulate (my idea of an accelerating bailout tax for banks), you do see a lot of very skirtable rules on capital requirements (which they had to do, but are hard to do perfectly), you see some odd and likely counterproductive restrictions on how banks are able to offload risk with derivatives (because everyone assumes that derivatives are to pad a bank's bottom line, not to offset risk - sometimes true, but just as often not true), and you increase uncertainty with the condition that the government can seize any firm deemed to be a systemic risk, as designated by some council of regulators with no guidelines at all. Isn't that what crushed the market after Lehman and Fannie/Freddie failed (that's on Paulson/Bush, not Geithner/Obama)? People thought they knew what would happen to their securities (in this case, a government bailout), then they get surprised by Lehman's equity getting wiped out and the completely useless evisceration of Fannie/Freddie's preferreds, and everyone decides to offload everything because it's too uncertain to own anything but cash anymore? Isn't certainty a good thing? Also, as another note, why are they auditing the supposed-to-be-independent Fed? I appreciate the importance of transparency (I will be talking more about this at length in my discussion on housing below), and I suppose from that perspective it's a good thing, but if it gives Congress license to shove the Fed around for political aims, then it's a really, really bad idea.

(EDIT: I didn't realize this bill still held the ratings agencies legally liable for their ratings. That is a TERRIBLE idea. See 2.3 below)

Let's put it this way: I don't claim to know comprehensively what should go into financial reform, but there are a number of features which I know would have helped - maybe more things were needed, but these ones would all be helpful, I think. Of that list (footnote 2.2), which had 19 things, there were perhaps 4 that got implemented. There were also some things which I thought would be explicitly harmful. Of the things I thought would be harmful (a list of 5 things), 3 were implemented.

It is my opinion (I haven't seen it elsewhere) that the decision rule for government spending should fulfill a pretty basic hurdle rate formula (footnote 3.1). The economic impact of any spending should be greater than the combined effect of interest payments on the debt used to fund it, the crowding out effect impact, and the effect of raising taxes later to pay off that debt. Even relaxing that to make it practical, you can justify ignoring the latter effect (effect of later taxes) if there is some unmeasurable but definitely-bad effect of a particularly deep downturn today - in other words, if the range of outcomes could get really bad now because you're in a collapse, you can justify redistributing future economic benefit to today to be safe. Still, that means you need impact to exceed your own interest costs - not just present interest costs, but all interest costs you will incur on that debt before paying it off.

Now, in a downturn crowding out is minimal, but interest costs, while presently low, have to have some of the long term rate incorporated in, or else you'll end up spending a ton now with low interest costs and get CREAMED when you have to refinance.

Which brings us to stimulus. Again, we look at "idea vs execution". We absolutely needed a stimulus bill, there's no question about that. However, it was important that if we were threatening the US credit situation, we needed to get bang for our buck - in other words, maybe you'll create uncertainty and bond worries, but you'll be using the money to such great effect that the effect is outweighed.

Instead, we got an absolute atrocity of a bill.

It was protectionist (sparking serious trade concerns, which is exactly what we DIDN'T need at that point - I'll talk about trade again later, as well). It required only union labor, which is way more expensive and got us significantly lower stimulus efficiency. Going line-by-line through the stimulus, about a third of it was total pork, fulfilling a Democratic wishlist. (The exact number I got was 36.5%, but I also understand that a lot of issues could have gone either way, and even now, there are elements I would have changed my tone on.).

If you're going to create the prospect of substantial future taxes while increasing the US interest payments and debt servicing burden, you need to get bang for your buck. This is especially true if it's the one shot you have, because the debt markets would clearly not support another stimulus of that size at this point. Social safety net provisions are important, but this stimulus needed to be designed to impact the economy absolutely maximally, not fulfill 8 years of pent-up Democratic angst. Even the classically good stimulus provisions were misimplemented - high speed rail lines are a decent investment if done in the right place (though many would argue that buses are a better focus of public transport), but the high speed rail lines being installed are going through areas with no population density and will never earn back their cost (the best measure of economic impact). They should have been built in Southern California and the Northeast Corridor, but political payoffs dominated smart stimulus design.

Was the stimulus too big or too small? It's hard to tell, when the impact of the trillion dollar stimulus was probably what you would have gotten out of a better-designed stimulus half the size. The sad thing is that there are plenty of areas we really do need to upgrade spending on (the electricity distribution grid is in critical need of major upgrades just to avoid brownouts and blackouts, to say nothing of handling a more variable solar/wind load, the highway system is a disaster, etc), but the focus on "shovel-ready" projects meant all of the projects were crappy. Implement the better, slower projects, cut the pork and pay it out as a payroll tax cut, NEXT YEAR. That way, employers don't fire as many people (this upcoming year, employees will cost less) and by the time that wears off, you'll have projects gearing up. This wasn't that hard to design, but Democratic supermajority killed any prospect of a bipartisan compromise (which is what this would have resulted from).

I mentioned earlier that the economy cares about progressive ideals about as much as the climate cares about conservative energy ideals, and this is particularly apparent here. Yes, it'd be nice if we could give everyone as much unemployment as they needed without disincentivizing them from retraining for new work or finding a new job. It'd also be nice if we could burn coal forever and not worry about climate change. It's been estimated that unemployment extensions have added between a percentage point and a percentage point and a half to the unemployment rate. Certainly, I don't buy into the right ideology that unemployment makes people just coast on the government forever, but the left ideology that unemployment benefits are so low that nobody would not find a job because of them is just as incorrect. The most plausible condition on this, to me at least, is that people look, but are way more selective about what jobs they'll take until their unemployment is about to run out. That's not a good thing in high unemployment conditions - if people take a worse job, and then when employment is higher find the job of their dreams, it costs less for everyone and they themselves are more marketable (long unemployment makes you less marketable).

The sad thing is, there's a happy medium. I had the idea of starting unemployment at a higher rate and decreasing the payout weekly, so people don't wait to find a new job. Scott Sumner suggested unemployment be paid as a lump sum. But ideology won out over pragmatism here, and unemployment suffers as a result of it.

There's another problem here that people talk about less. Businesses pay an unemployment tax per worker based on the level of unemployment benefits provided by the government, so increased unemployment benefits actually serve as a disincentive to hiring. So all of these unemployment extensions actually increase unemployment by destroying jobs.

The prospect of a future tax increase makes people save more of their current salary in the presence of partial (or, heaven forbid, full) Ricardian equivalence. Of course, the paradox of thrift is that we need people spending now, not saving. We also need people producing as best as we can, and increasing tax rates on high-income people to that extent also disincentivizes work. Finally, taxes on dividends are going back up to 40%. This encourages businesses to just stockpile cash on their balance sheets to wait for a good time to buy back stock, instead of paying out cash as dividends that would actually get spent by recipients.

It's unbelievable to me that people actually are excusing the fact that Obama and the Democrats are allowing income taxes to go up in the MIDDLE OF A RECESSION/DEPRESSION. I say only half-jokingly that this alone should be enough to impeach for incapacity. The deficit is really important (lord knows I talk about it a lot) but you don't focus on the deficit in the middle of a recession, you focus on convincing people now that the deficit will be fine later, so they don't need to save for higher future taxes. This literally looks to me like Obama is saying "this is the only possible way I can raise taxes without causing an uproar, so timing be damned, I'm raising income taxes!" It is ideological petulance at its worst - if he wants to raise taxes on private incomes/spending (which seems to be the lazy and inefficient way out, relative to cutting the much more wasteful government spending), he could at least extend the Bush cuts by 2 or 3 years. That keeps the long-term fisc relatively the same (taxes still are going up), doesn't cut government spending (sigh) but doesn't RAISE INCOME TAXES IN THE MIDDLE OF A DEPRESSION.

6) Budgets and the prospect of neverending deficits above a sustainable (~2%) rate

Obama used accounting sleight of hand in his most recent government budget. He treated the short-term (by government standards) military expenses of Iraq and Afghanistan as permanent spending, so that government expenditure does not have to come down at all when Iraq and Afghanistan costs go down. The funny thing is that liberals EVISCERATED Bush for spending that much on a war, but excuse Obama trying to spend that much forever.

Even so, Obama has found enough other various avenues of spending that his long term budget deficits are 50% higher than Bush's ever were going to be, assuming Obama's own very rosy economic forecasts (which everyone has criticized as being too optimistic, and the last year has borne that out).

Business leaders respond to anticipated laws - they have to - so allowing chatter of a VAT is a TERRIBLE idea in a recession, along the same cardinal problem as allowing income taxes to go up in a recession/depression. If you're a business, and you're looking at the prospect of a VAT, and looking at how fast it swelled to a high rate in the rest of the OECD, why on earth would you hire a single worker or build a single factory here if you could avoid it? Wouldn't anyone even remotely close to the "US or Foreign production?" margin either just build abroad or decide to wait until this has shaken out?

A competent leader would have come out and unequivocally said "I will veto any attempt to create a VAT for the foreseeable future" and left it at that. Setting aside the fact that a VAT is way worse than a national sales tax because it is a logistical nightmare and a recipe for political favoritism and political footballs (look up how a VAT is calculated in the rest of the OECD and you'll see why), even if you intended rolling one out, you shouldn't let a WHISPER of it out right now.

8) Pledging to double exports, ignoring/misunderstanding the dynamics of why our trade deficit is the size that it is

Up until Obama's pledge to double exports, I had thought he was ideological but never got the sense he's incompetent. I understand part of it is political, but if he's promising to double exports, he's going to look like an idiot when real exports drop (A strong possibility. I have no idea what nominal exports will do because I have absolutely no idea whether to expect inflation or deflation right now, and that's the Fed's fault - I'll get to this in a bit, also). The fact that he thinks it's POSSIBLE to double exports in the current world trade system indicates a fundamental misunderstanding of what actually is affecting the economy.

Trade is subject to a pair of very simple, intrinsically related identities - the current account balance and the capital account balance. If China exports one widget for $1 to the US, then China has a $1 current account surplus (net exporter of goods) and the US has a $1 current account deficit (net importer of goods). That dollar goes from the US to the Chinese, which means the US is a net exporter of capital (they're sending a dollar to China) and China is a net importer of capital. In essence, the capital account is a claim on future current account - if I am China and I import capital on a net basis now, it means that later on, I have the money to import more goods on a net basis.

It should seem obvious on this micro scale that the sum of all of the current account surpluses and deficits in the world must equal 0. Similarly, the sum of all of the capital account surpluses and deficits must equal 0.

In a free trade environment, these surpluses and deficits should tend towards 0. If the US wants more goods from China than China wants from the US, then in the absence of intervention, what should eventually happen is that demand for the Yuan drives the Yuan to strengthen vs the dollar, and the relative overavailability of dollars drives the dollar to weaken, and the exchange rate shifts until demand for Yuan and demand for dollars is balanced, which happens when neither country has a trade deficit or surplus. In real life, all sorts of exogenous shocks and time-lagged responses mean there would be a cycle of surpluses and deficits, but they would be small, and over time, one would expect them to balance.

However, we don't operate in a free trade world.

There are two large regions that have imported a great deal of goods over the last decade on net (and exported a lot of capital) - the US and Southern Europe. There are two large regions that have exported a great deal of goods over the last decade on net - China/Japan/East Asia and Northern Europe.

Furthermore, as Michael Pettis (the single best blogger alive right now, in my opinion) points out, Northern Europe and Southern Europe have largely balanced each other out. The US has mostly offset China and Japan, and the world stays in balance.

Well, southern Europe is screwed - Greece, Portugal, Spain, Italy - and they will have trouble importing nearly the same amount as they have been.

However, the exporting countries are largely structurally dependent on exports. Germany, Japan and China have all significantly favored their export production businesses and artificially kept down consumption (I encourage you to click on either of my Chinese Currency footnotes or anything Pettis has ever written on his blog, if you're interested). Thus, in order to not shock their economies, China and Japan are working to ensure their export balances stay high to keep their businesses healthy, because otherwise consumption would not really be able to ramp fast enough to offset the rapid reduction in exports. Germany and the rest of northern Europe are doing that, also, and they also benefit as exporters by the weakening of the Euro caused by their southern neighbors.

We know we need balance, and everyone's exports are staying high. Who do you think is going to be importing more?

Thus, as southern Europe collapses, the US will probably be importing more than ever. Who exactly would absorb the doubling of exports? The US is still (I believe) the third largest exporter in the world (behind.... China and Germany!). There's not enough import capacity in the entire world to double exports. It's not happening.

I understand that Southern Europe wasn't quite as acute a problem when Obama made that promise, but he still had a team who had to see this coming, plenty of economists did. A country as large as the US, Japan or China should not have a structural deficit or surplus, and only because we've been anesthetized by 20 years of reversing our strong prior export record did we miss this.

The reason this relates to economic mismanagement and wasn't just a political promise or a misunderstanding was that this particular arrangement means that in essence, China, Japan, Germany and the rest of Northern Europe are exporting their unemployment to the US. China, especially, routinely violates WTO dictums to keep their export balances high. This is not a trivial problem for China, and it's a sensitive issue, but the complete lack of attention to this in favor of more ideological bills (healthcare, consumer financial protection, etc) is a massive, massive problem for Obama's economic record. It's the equivalent of fiddling while Rome burns.

What SHOULD he be doing? I talk about it in the footnote 8.3, but the Warren Buffett proposal for import certificates is one that I can get behind - in essence, tax imports the exact percentage required to balance the trade deficit. As the trade deficit drops, the tax drops. This would have to get past the WTO, but other countries would have a lot of trouble retaliating because there are no other large importers in the world right now. If there were other large importers, you could just not tax goods from that country.

He's also done a terrible job of framing energy as a trade issue. Oil is a third of our imports, and getting gasoline out of the car fleet would increase employment by quite a lot (as well as having beneficial effects on the climate and arguably security).

Finally, it's impossible to cut the trade deficit with a persistent government deficit, because the government deficit is high enough that it can't be financed at a low interest rate internally, so foreign countries currently finance the govenrment deficit (Chinese and Japanese especially, right now). In a recession, this isn't such a big deal because interest rates are low, but Obama needs to credibly show now that he will reduce the government budget deficit beyond a couple years from now in order for employment to really rebound with any strength.

Can someone explain to me why it's a good thing to let an R&D tax credit expire, ever, and especially in a recession? R&D is how companies find new products (essential for GDP, employment, etc), and higher corporate taxes aren't good. This is simple, but it's so dumb, and it gets ignored. Not only should the R&D credit have been extended, companies should have had the option of capitalizing it on their balance sheets. That way, R&D spending gets cut less in the recession, more researchers stay employed, and companies have more of an incentive to use R&D because they can tax-deduct the depreciation as well (essentially, double tax crediting R&D)

One of the more harmful and less talked-about actions taken by the Obama administration happened early, when he was working on a bailout for the automakers. Without commenting on the actual automaker bailout (on the one hand, those companies were slaves to unions, horrifically mismanaged and should have been allowed to die, but on the other hand, saving them is the cheapest way on the planet to save 2 million jobs for now), I should point out that Obama arbitrarily forced senior bondholders to take a haircut in a way that was a) unconstitutional and b) established an early "anti-business" reputation. The move significantly increased the required interest rates on distressed debt, because of the risk that things would get bad enough that the government would step in and haphazardly decide for political reasons who takes haircuts (bondholders and hedge funds) and who doesn't (the unions, or at least not nearly enough of one). There is very little worse for capital markets than highly uncertain risk, and capital markets feed back into the real economy, as we've found with the credit crisis.

11) Housing price prop up to avoid foreclosures

Quoting Arnold Kling: "Everyone knows that the housing market and the mortgage market are artificial. The mortgage market is being propped by by Fannie, Freddie FHA, and the Fed. The housing market is being held in a state of suspended animation by government attempts to stave off foreclosures. This policy is keeping the foreclosure crisis in front of us rather than putting it behind us.
If it had been up to me, I would have put in place policies to accelerate getting people out of houses where they don't belong. I would have given subsidies to underwater borrowers to move, and I would have given them bonuses for leaving houses in good condition. I think that if we had a housing market with a reasonable relationship between where people live and what they can afford, then the economy would be humming by now."
My note: I think that's probably an exaggeration, but it certainly would have credit flowing better by now, which is a critical step to recovering. Debt levels probably would be much lower, as well, as banks would just be forced to eat credit losses instead of having an elaborate shell game between the government, banks and consumers, hiding who is solvent and who is not. There is a major timing effect (you want to have the economy starting to recover as the level of government spending drops, which it has been doing for a few months now) which anti-foreclosure efforts have been harming. Finally, there's also a major uncertainty factor - when people don't really know how much housing is supposed to cost, a lot of decisions get delayed or avoided. Mortgages are harder to get, producers of building materials have trouble hedging and thus don't spend on capital improvements or labor, and people wait to buy houses because housing prices could drop and at the very least will stay low for a while. This is a MAJOR demand sap.

I pair these as part of a backwards-looking labor policy. Almost every economist agrees that minimum wages increase unemployment more than they help people who receive the higher wages, and hit the uneducated, teens and minorities particularly hard. Notice who is bearing the brunt of this recession the worst of everyone? see 12.1

Similarly, union card check and other pro-union policies (Adam Stern was Obama's number one visitor in his first year, with 23 white house visits) increase the cost of labor and decrease employment. Unions had their uses (more in footnote 12.2) but right now, just decrease employment and decrease corporate efficiency (and incentivize companies to move production elsewhere).

and the two factors over which as president he could possibly influence but are also partially out of his control (I don't talk about these much because these would require some very nifty legislation on commodity production or more intervention at the Fed than may be appropriate).

13) commodity price pressure from China, and the complete lack of any addressing of it

Commodities should not be this expensive right now. A weaker dollar than 10 years ago is part of it, but there's also the "China is using a lot of commodities and stockpiling even more" factor. Stimulating domestic production would help a great deal (subsidy, tax credits, etc), but it'd be hard to avoid subsidizing overcapacity. Legislation would have to be pretty carefully constructed, but also would help if executed well. Note that things like grid upgrades or natural gas storage/transport subsidy or highway improvements could have this effect and also be stimulatory.

14) focusing on pulling the stops out on the fiscal side but ignoring some very legitimate, much better monetary options

Scott Sumner has talked a great deal about Nominal GDP targeting, which is one option, and there are certainly other monetary options that don't require fiscal damage. All would increase inflation, but many of them could still keep inflation controlled (inflation targeting or ngdp targeting) and many others are adjustable back down when inflation stops being a good thing, as it is right now (Fed paying nontrivial interest on bank reserves, discouraging lending). Deflation is the biggest risk right now, and deflation is WAY worse than controlled inflation a little higher than what we've seen over the last 20 years. I highly recommend http://www.themoneyillusion.com/ for all sorts of details on this stuff.

Thursday, July 15, 2010

"In my view, the biggest problem with the economy right now is that everyone knows that the housing market and the mortgage market are artificial. The mortgage market is being propped by by Fannie, Freddie FHA, and the Fed. The housing market is being held in a state of suspended animation by government attempts to stave off foreclosures. This policy is keeping the foreclosure crisis in front of us rather than putting it behind us.
If it had been up to me, I would have put in place policies to accelerate getting people out of houses where they don't belong. I would have given subsidies to underwater borrowers to move, and I would have given them bonuses for leaving houses in good condition. I think that if we had a housing market with a reasonable relationship between where people live and what they can afford, then the economy would be humming by now."My note: I think that's probably an exaggeration, but it certainly would have credit flowing better by now, which is a critical step to recovering. Debt levels probably would be much lower, as well, as banks would just be forced to eat credit losses instead of having an elaborate shell game between the government, banks and consumers, hiding who is solvent and who is not. There is a major timing effect (you want to have the economy starting to recover as the level of government spending drops, which it has been doing for a few months now) which anti-foreclosure efforts have been harming. Finally, there's also a major uncertainty factor - when people don't really know how much housing is supposed to cost, a lot of decisions get delayed or avoided. Mortgages are harder to get, producers of building materials have trouble hedging and thus don't spend on capital improvements or labor, and people wait to buy houses because housing prices could drop and at the very least will stay low for a while.

http://www.nakedcapitalism.com/2010/07/satyajit-das-examines-eurozone-stability-fund-three-card-monte.html
"The Eurozone has taken this affinity for financial structuring legerdemain even further, drawing on the most abused structure of the crisis, collateralized debt obligations, to create (as before) super duper AAA credits from less promising material. "My note: One of the things that's been most interesting about watching the initial American response to the crisis and watching current American policy and European policy is that the initial response was actually pretty brutally open - it's hard to "cover your behind" if it's painfully apparent that you're insolvent and you need help. This transparency helped with devising good policy to move forward (TARP comes to mind). It seems that America has lost patience with the concept of insolvency and now everyone wants to "move on", before the problems have shaken out. This results in obfuscatingly bad policy. Europe has been even worse... for example, did you know that European bank stress tests assumed a worst case 3% default on Spanish bonds and 17% on Greek bonds? That's not a real stress test, that's probably more optimistic than even the base case is, unless Germany intervenes. However, it makes it look like "European banks have been stress tested and they're fine!", which prolongs the problem

http://mpettis.com/2010/07/the-capital-tsunami-is-a-bigger-threat-than-the-nuclear-option/My note: I don't quote the article because Pettis' entire take is, as usual, magnificent. I've written extensively here: http://tfideas.blogspot.com/2010/02/detailed-mechanism-of-inflation-in.html. I would also point out that the capacity overhang I mention in the article is no longer there in a lot of places - a lot of raw materials, and even labor. So we're starting to see limited inflation there. This is a crisis that is only just beginning to loom, and either the US is going to eat it and keep unemployment high or we're going to deal with it substantially. Obama's promise for doubling exports in 5 years is laughable, unless he intends accomplishing that through US inflation (which is certainly possible, if somewhat improbable, and hardly seems an accomplishment) - we would be lucky to have higher (real) exports in 5 years than we do now.

Apparently, this year, we reached gender parity in schooling on an international level. In other words, if you select a random woman and a random man across the world, the expected value of the number of years of schooling they receive is the same.

We can still see problems in the distribution. As Alex Tabarrok notes, there are a small number of countries where women receive significantly less schooling offset by a large number of countries where women receive somewhat more schooling. I would argue that certainly the countries where women are massively undereducated have a major problem with educational equality, and it's likely that the countries where women are educated somewhat more have structural problems with educational quality (not missing the e) - the US is an example, where it's been well-documented that the structure of the American classroom is very poorly suited to male brain development.

I don't know what the "optimum" level is*, but you'd expect to see it within a reasonable margin of individual country-by-country parity, and that is clearly not the case in the data. Still, worldwide parity is not a small achievement given where the world was just a century ago.

*ideally, you'd want everyone to have exactly as much education as they want, which you'd expect would line up approximately with the productivity value of education, with a fudge factor for the fact that school is more fun than work but less fun, for most of the world, than doing neither work nor additional school. There are four reasons I can think of why this may not line up into perfect parity between genders on education:

1. We don't know biological determinants of intrinsic desire to be in school for more time, and assuming the substantially wide distributions among both men and women are centered at the same point is no more valid an assumption than assuming they're different in either direction. You would expect them to be close to each other, though.

2. A woman exits the work force to have children for much longer than a man does so may on some level value education less because it results in less net additional productivity over a lifetime.

3. Disease rates, war/accident fatalities, and other such catastrophes may make the length of the female working life greater than or less than the length of the male working life, which would result in different average education levels because of different net additional lifetime productivity as a result of additional education.

4. Chosen labor types differ between genders. Men and women differ physically (duh), and neurologically, men and women perceive numbers and words differently, and also perceive risk differently, which may lead to different career choices even under perfect freedom. Education may differentially affect productivity of those careers. For example, if communication skills can be learned outside of school but math needs to be learned in school - and this is a hypothetical, i don't know if it's true - you would see more people intending math-heavy careers be in school for longer. At the most extreme case, hard manual labor, for which men are better equipped, may see differential (probably lower) productivity benefits from schooling.

Tuesday, July 13, 2010

I know people have been doing a lot of research recently on the unbelievable variety of bacteria that exist all over you, and how even small differences in location (forehead vs cheek, or canine vs molar) can mean an entirely different bacteria set... but this article is by far the coolest one I've read on the topic.

Does this make sense to anyone? Is this a political maneuver to turn up the heat on immigration legislation? Or is Obama's head of INS more administratively competent, which means INS functions more effectively and deports more people? Or is it a response to detention centers, where they're considered unhumanitarian (justifiably) and thus the more humane alternative in most cases is deportation? Or is there a disconnect between an immigration-supporting central immigration and anti-immigration (and growingly so, given high unemployment) agents and judges who carry out deportations?

This is a disappointing graph, certainly - criminal deportations are one thing (hard not to support those), but non-criminal deportations don't seem to make much sense to me, given that we don't live in a welfare state, the majority of immigrants are indeed employed, and most immigrants provide far more than they take from society.

Monday, July 12, 2010

When faculty of a major Chinese university asked Plucker to identify trends in American education, he described our focus on standardized curriculum, rote memorization, and nationalized testing. "After my answer was translated, they just started laughing out loud," Plucker says. "They said, 'You're racing toward our old model. But we're racing toward your model, as fast as we can.' "

Perhaps it's no surprise. Centralized bureaucracy works terribly in almost every other American endeavor (the military excepted, and the discipline of soldiers is far beyond any reasonable discipline expectation of kids and thus teachers). How would one create a decentralized educational system? I've mentioned before my preference for student-directed, teacher-supervised projects, but that's difficult to implement, especially as class sizes get large.

Thursday, July 1, 2010

I feel reasonably certain that there is something wrong with my logic here, but I'm hoping someone can explain to me what is wrong.

A government should spend on something if the economic impact (call them the economic returns) of that spending will eventually exceed the cost borne by the government. This government cost is a blend of its interest rate, the economic activity displaced by government spending (crowding out), and the economic activity displaced by current and future taxation to pay off the cost of the project. In mega-recessions like this one, interest rates are near zero because of deflation fears, and the economic activity displaced by government spending is very low because there's so much extra capacity in the economy that government spending doesn't drive prices up much. Thus, project cost is reduced to the level of economic activity displaced from the private sector by taxation.

What this implies is that the government spends more in mega-recessions like this one. It does not imply that the government should will spending up (a la the Keynesian solution), and it does not imply that the government should cut back and do nothing (the tea party solution), it implies that the government should continue the exact same process of project evaluation but the hurdle rate for acceptance is lower, so more projects get taken on. Thus, government spending should be countercyclical.

Is this absurdly reductionist? It's how corporations are supposed to evaluate their projects, in theory - cost of equity capital (analogous to taxpayer cost), cost of debt capital (interest rates) and opportunity cost of projects, both in management time and attention and capital raising limits (analogous to crowding out).

Obviously this doesn't address nasty problems like wage stickiness and some of the other things that Keynesian economics tries to analyze (and, at least it seems to me, is dubious in its application). However, while the Federal Reserve needs to do those kind of analyses for determining interest rates and optimal monetary policy, the federal government as a whole should be able to take these costs (interest rates, crowding out and taxation), treat them as exogenous, estimate them and use that as a decision rule, right? What's wrong with this picture? I understand that politically it's hard to estimate in an unbiased fashion, because each party will find ways to make their pet projects pass the decision rule, but on a theoretical level, isn't this how it could work best?

(Before anyone starts yelling at me for inconsistency on deficits, there's a big difference between temporary spending now and permanent spending increases. We can't have permanent spending increases because of the debt. We can, however, run a deficit now, during the recession, as long as we ensure that it ends when the recession is done. We also can't have spending that is destabilizing from a taxation and business uncertainty perspective, but contributes no economic stimulus. Healthcare reform, I'm looking at you, and that's just scratching the surface on your flaws...)